Financial Stability Board (FSB) Chair Klaas Knot has addressed some of the risks around digital assets and the wider use of decentralised finance (DeFi) in a letter to G20 finance ministers and Central Bank Governors.

“The events of the past year, such as the collapse of FTX, have highlighted the intrinsic volatility and structural vulnerabilities of crypto-assets. We have now seen first-hand that the failure of a key intermediary in the crypto-asset ecosystem can quickly transmit risks to other parts of that ecosystem”, Knot said. “And, if linkages to traditional finance grow, risks from crypto-asset markets could spill over onto the broader financial system.

Stablecoins not compliant

To address the lack of regulation, supervision and oversight of crypto-assets and markets, the G20 has given the FSB responsibility to coordinate an “effective and comprehensive regulatory framework for crypto-assets”. The FSB will finalise its recommendations this year, and the global arrangements for stablecoins include:

• guidance to strengthen governance frameworks; and
• clarification and strengthening of redemption rights and the need to maintain effective stabilisation mechanisms.

However, the FSB concludes that many crypto-assets and markets are currently not compliant with applicable regulations, and that existing “stablecoins would not currently meet these high-level recommendations, nor would they meet the international standards and supplementary”.

The FSB also believes that some of the stablecoins could “have characteristics that may make threats to financial stability more acute”.

“We have now seen first-hand that the failure of a key intermediary in the crypto-asset ecosystem can quickly transmit risks to other parts of that ecosystem.”

Klaas Knot, Chair, FSB

DeFi risks

The FSB is also stepping up its work around decentralised finance. In its recent report on the DeFi and its financial stability risks, the FSB warned that the ”growth of DeFi has potential wide ranging implications for traditional financial markets, and DeFi inherits vulnerabilities of that system and may amplify them”.

The FSB suspects that vulnerabilities such as operational fragilities, liquidity and maturity mismatches, leverage, and interconnectedness may lead to financial stability concerns over the interlinkages and associated transmission channels between DeFi and the traditional finance market.

The report also pointed to the need for proactive monitoring of this fast-growing technology, to fill data gaps and explore what crypto-assets may need to cover DeFi risks.

“Data on crypto-asset markets in general and DeFi specifically, lack transparency, consistency, and reliability,” it stated.